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A common question that I receive relates to rental of a property to a family member. The tax issue is whether the owner of the property may treat it as a “normal” rental, claiming all of the ordinary deductions allowed to a landlord.
This may seemingly be answered, “Why not?” But when a rental is to a family member, a sticky fact that often surfaces is that the family member is offered a bargain rental rate.
The bargain rent can convert what appears to be a rental property into a personal-use “vacation home.” Tax deductions are limited for vacation homes. Interest and taxes are allowed, but things like insurance, utilities and repairs may not be.
Personal use includes, well, personal use. But it also includes any rental to a family member unless two tests are satisfied. First, the family member must be using the property as a principal residence. Second, the family member must pay fair rental value (FRV).
The problem is that FRV means 100% of fair, and not a dollar less. And the owner needs some proof that FRV was charged.
Many times the owner will ask whether they can charge less than FRV because the family member will be doing some work on the property. That actually seems to make sense, and we need to celebrate sensible taxpayer suggestions.
But it always gets tricky, and it often seems that the family member really is doing nothing more than “keeping an eye on things.” There generally isn’t much of a market value for a wide-eyed tenant.
But last month a taxpayer actually won one of these cases, the first that I can recall. Dad rented his house to his son and the son’s family. The son received a bargain rent in exchange for maintenance services. The Tax Court said that the amount paid, plus the value of the services, equaled FRV, and the taxpayer won the case.
In this particular situation, the renters actually worked, and really hard. They repaired mold damage, fixed holes in walls, repaired rotting subflooring, prepared floors for carpet installation, painted the interior of the house, renovated the kitchen, replumbed for gas, replaced electrical fixtures, landscaped and more.
I stopped at “more” only because I was getting tired. And they also chased off rats and even one bear. They confronted a bear for a break on the rent! This is what tax advisers call a “good” fact pattern; that is, one that you seldom see.
So if you want some support for a below-market cash rent in exchange for services, William P. Adams is the case. But if your family just isn’t the type to tear apart and rebuild houses, and chase away the occasional bear, the Adams family may not be the best case to throw in the face of the IRS.
And if that’s a downer, now consider what our national Taxpayer Advocate, who is there for you and me, told the Congress about the state of our tax system.
It seems that only 16 percent of us think the tax law is fair and that only 12 percent of us think that everyone pays their “fair share.” Those numbers beat only Congress’ approval rating.
The reason this matters is that when people think the game is rigged, they are willing to cut a few corners themselves, particularly when IRS enforcement budgets are chronically underfunded. A bad attitude toward the law combined with no enforcement creates an environment such as when the town of Vaughn had a dog as its only certified cop — even a Smart car can outrun a police dog and everyone is willing to try.
So we have a bad tax system filled with deductions, exemptions and credits, which many are willing to exploit because they feel everyone else is, and Congress won’t fund the only agency that actually makes money for the government.
The Taxpayer Advocate suggests that we do away with the deductions and exemptions and lower the rates as the taxpayer’s reward. It is possible, if both political parties work together, don’t criticize each other as the process unfolds, and jointly accept blame for loss of deductions that people like. Hmmm … finding a family willing to chase bears is more likely.
James R. Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.<br>
